Standstill and insolvency: a new mechanism for the IMF?

17 January 2002

18 December 2001 – In a surprise anouncement in late November the new number two at the IMF, Ann Krueger, has proposed that the IMF should support temporary debt standstills for indebted countries. Krueger described the mechanism as “the missing element” to fill a “gaping hole” in the international financial system.

“At the moment, too many countries with insurmountable debt problems leave it [debt restructuring] too long, imposing unnecessarily heavy economic costs on themselves, and on the international community that has to help pick up the pieces,” commented Krueger.

However, it is likely to take up to three years before a mechanism would become operational meaning that Argentina (and possibly Turkey) will not benefit.

IMF sanction of a suspension of debt payments would offer a country protection against private creditors taking legal action to recover debts in full, giving the government breathing space to work out debts in a more orderly fashion. The IMF has also indicated that it would support the temporary use of exchange controls during the standstill period, limiting the amount of cash creditors could take out of the country. In return the government would be expected to negotiate a restructuring agreement with its creditors and implement sound economic policies.

Both the US and the UK governments have expressed support for the idea. UK Chancellor, Gordon Brown, announced in a speech prior to the rescheduled Annual Bank and IMF meeitngs in Ottowa in November 2001 that, “…we also need to resolve the legal obstacles that stand in the way of effective debt reschduling – including the steps that would create an effective international bankruptcy procedure. And we should be prepared – where other reasonable options have been exhausted – to support a country that must impose temporary capital controls, or a standstill on its debts, as part of an orderly process of crisis resolution.”

The standstill proposal is regarded as an alternative to huge IMF loan packages – given in recent years to Mexico, Indonesia, Thailand, Korea, Brazil and Turkey – which have been severly criticised for bailing out foreign investors whilst failing to prevent crises. Instead, by forcing foreign investors to feel more of the pain, it is argued a standstill mechanism would encourage them to make better investment decisions. Backing a voluntary standstill approach, the Bank of England and Bank of Canada have argued in a paper published in November for strict, clear limits on IMF lending to crisis countries. Limits on bailout loans would force countries to rescheduling debts earlier.

Krueger’s proposal stops short of suggesting that the IMF should act as a judge in the debt renegotiation process. It is the country’s task to reach agreement with its creditors. Several NGOs in the Jubilee debt campaign, academics, such as Kunibert Raffer, Vienna University, and Jeffrey Sachs, Harvard University, and specialists at UNCTAD have been advocating for clear rules for debt restructuring procedures, which treat debtors and creditors fairly. Groups such as Jubilee Plus have been arguing for a “Fair and Transparent Arbitration Process”. All agree that the IMF should not be the administrator of such a mechanism on the basis that it is often a major creditor and that its debts have privileged status.

“…their [The IMF‘s] willingness to refrain from adjudicating the process of negotiation between international debtors and creditors, must be welcomed. Instead this process should be overseen by an independent arbiter/judge”, commented Ann Pettifor, New Economics Foundation.

A “fair and transparent process” would include:

  • a neutral decision making body independent of both creditors and debtors;
  • the right for all stakeholders to be heard before a decision is made;
  • protecting the debtors’ needs before debts are collected, particularly protecting the most vulnerable sectors of society.

Pettifor favours a mechanism modelled on Chapter 9 of the US domestic bankruptcy code: “…because it democratises the process for resolving a public debt crisis”. Giving citizens a “right to be heard”.

Under Chapter 9 legislation, citizens have the right to participate in the debt re-structuring negotiations. It is used for governmental organisations, like municipalities in the US, and protects the right of municipal debtors to continue providing services, and to not have these services cut back by creditors. The US Supreme Court has ruled that municipalities are not required to increase taxes to make repayments.

Although the IMF will refrain from adjudicating disputes and verifying creditor claims Krueger insists that the IMF should be central to a debt-standsill procedure: “The Fund’s involvement would be essential to the success of such a system. We are the most effective channel through which the international community can reach a judgement on the sustainability of a country’s debt and of its economic policies, and whether it is doing what is necessary to get its balance of payments back into shape and to avoid future debt problems.”

UNCTAD contests this: “…the IMF Board is not a neutral body and cannot, therefore, be expected to act as an independent arbiter, because countries affected by its decisions are also among its shareholders…An appropriate procedure would thus be to establish an independent panel for sanctioning such decisions.”

It is unclear whether the IMF would try to establish standardised “debt sustainability” criteria (as were established for the Heavily Indebted Poor Country Debt Initiative). While the government would declare a standstill, IMF sanction would be based on a judgement of debt sustainability. Extensions to the standstill (which is expected to be imposed for only a few months) would be subject to IMF agreement that governments had taken necessary steps to adjust policies.

“There is a clear analogy here with the way the Fund ensures that countries get their policies back on track when it is lending to them. Like an IMF-supported adjustment program, the standstill could be endorsed for limited periods and renewed following reviews of the country’s economic policies and its relations with its creditors”, commented Krueger.

Whilst there is doubt about the IMF‘s role as arbitrator of a standstill and adjudicator of the debt restructuring process, the IMF should have a role in providing a country with new loans. Krueger has already indicated that the IMF will provide limited finance: “After the restructuring, Fund financing should be limited to the amount necessary to help rebuild reserves and pay for essential services and imports. There should be no extra support to help finance payments to creditors on the restructured debt.”

Whilst there has been a sudden flurry of activity around the standstill idea, creating a bankruptcy mechanism under the auspices of the IMF could take several years. It wil probably entail a change in the Fund’s articles of agreement, requiring an 85 percent majority of the Executive Board to be in favour, and possibly changes in the laws of many of its member countries. Approval by the US Congress is key since the US has a 17 percent share of the votes on the IMF Board, enough to block this initiative. The previous US government objected to such a mechanism on the basis that US law requires all creditors to agree to a debt restructuring deal and that to change the law would be politically contentious.

Ann Pettifor’s comments

NGO letter on a Fair and Transparent Arbitration Process

Ann Krueger’s speech

The Resolution of International Financial Crises: Private Finance and Public Funds, Andy Haldane and Mark Kruger, Bank of England and Bank of Canada

Papers by Kunibert Raffer

Trade and Development Report, 2001, UNCTAD